Save yourself some car insurance grief: Buy gap coverage

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Last updated Sept 15, 2015

The dramatic plummet of your new car’s value as soon as you drive it off the dealer’s lot can put significant strain on your finances if your car is totaled .

If you’re entitled to an insurance payout for a totaled car, your car insurance company pays you the actual cash value of the vehicle. And the amount your insurance company calculates as your car’s actual cash value can be hundreds of dollars away from what you still owe on your car lease or loan, especially within the car’s first year of ownership. Since you’re responsible for paying the remainder of your lease or loan even when your car is totaled, you have to come up with the difference. Unless you have gap insurance.

Gap insurance pays the difference between the amount your insurer pays for your totaled car and the amount you owe on your lease or loan.

Within the first year, a car loses between 11 to 20 percent of its value, according to the National Automobile Dealers Association. For a car that costs roughly $25,000, that’s between $2,750 and $5,000 in the first year. However, certain vehicles retain their value better than others. For example, when gas prices skyrocket, resale prices for fuel-efficient cars increase.

Wrong assumptions

Many drivers wrongly assume that if their car is declared a total loss in an accident they’re going to recover the amount they owe on the car or, if it’s new enough, the amount they paid for the car. But cars don’t hold their value like that.

When you drive the car off the lot, you’ve automatically lost the fees you paid for things like licensing, destination charges, advertising and documentation. Those are one-time costs that you won’t get back if the car is totaled, but they are incorporated into the total price of your new car at purchase. However, you may be entitled to make a claim for reimbursement of sales tax when you purchase a replacement car.

With a car loan or a lease, you usually haven’t paid for that much of the car in the first year, so this is the time when the difference between what you owe and what the car is worth could be the greatest. Over the next two to three years, the car’s depreciation begins to slow. It then levels off, and by the fourth or fifth year of ownership, you can consider dropping gap coverage, since the value of the car and what you owe have usually aligned.

It is also worth remembering when you buy a new car that the most popular new cars are also the most popular used cars, meaning they hold their values better.

The road to gap insurance

Many car lease contracts include gap insurance but require you be in total compliance with the lease in order for the gap coverage to pay out. Most gap insurance policies offered through a lease contract require you to continue to make monthly payments until the gap payment is received.

If you decide to finance your vehicle through a bank, you probably won’t have a contract that provides you with automatic gap insurance. Many car insurance companies sell gap insurance but don’t advertise the fact. And some of the biggies don’t sell it at all. GEICO and State Farm Mutual Automobile Insurance Co. for example, don’t sell it.

Auto-Owners Insurance Co. is among those that do. But like many insurance companies, Auto-Owners offers gap coverage only to those who have bought brand-new, never-before-titled cars and who also have purchased comprehensive and collision insurance (if leased for 12 months or longer). “Auto-Owners [also] recommends that coverage be purchased when he or she initially purchases insurance, as this is when the gap is the largest,” says John Lindauer, spokesperson for Auto-Owners.

Other car insurance companies will allow you to purchase gap coverage up to 11 months after you purchase your car, or if the car is in the model year in which the insurance is purchased. Most car insurance companies have a cap, either in a dollar amount or in percentage, for total gap payout. For example, Progressive Insurance caps coverage at 25 percent of the vehicle’s actual cash value. Progressive estimates that it costs roughly $20 for the average six-month policy.

“Gap coverage can only be purchased on a vehicle that has both collision and comprehensive coverage and a loss payee or lienholder,” says Leah Knapp, spokesperson for Progressive. “The coverage can be purchased on any age vehicle, at any time during a policy term. A vehicle purchase date is required.”

Other companies that currently sell gap insurance or loan/lease payoff coverage are American Family, Erie Insurance, Esurance, MetLife and Safeco. However, most car insurance companies that offer gap coverage do not offer standalone gap coverage but as an “extra” on an existing policy.

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